Fannie-Freddie bailout looms over White House

Pressure is mounting on the Trump administration to fix Fannie Mae and Freddie Mac as the two mortgage giants grow increasingly vulnerable to another taxpayer bailout despite robust profits.

The companies are watching their capital dwindle as the Treasury takes most of their earnings, weakening their ability to weather market volatility and raising the odds of short-term losses. Corporate tax reform — a top priority of President Donald Trump and congressional Republicans — could force them to take huge writedowns.

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Treasury Secretary Steven Mnuchin says a fix for the companies isn’t at the top of the administration’s agenda. But without action from the White House or Congress, it’s all but certain that Fannie and Freddie, which back two-thirds of U.S. home loans, will need another taxpayer rescue on the Republicans’ watch.

“This would be a new bailout,” said Rob Zimmer, a lobbyist for the Community Mortgage Lenders of America. “Republicans own this town, and they will own this problem. It will be a big political black eye.”

Complicating the political calculus is the federal spending that Fannie and Freddie help finance. Allowing them to keep their profits would deny Congress revenue that could be used to cut taxes, pay for infrastructure projects and fund a repeal of the Affordable Care Act.

Given the slim chance for a legislative fix, some banks, investors and housing groups are counting on Trump to break the gridlock that has left Fannie and Freddie trapped under government control since the 2008 housing meltdown.

On Feb. 17, the Independent Community Bankers of America warned of “another massive bailout” if the companies continue to be starved of capital, an opinion shared by hedge funds and some lawmakers.

“There’s no reason whatsoever they shouldn’t be able to recapitalize,” said Michael Capuano (D-Mass.), a member of the House Financial Services Committee. “They’re being used as a piggy bank.”

It might seem farfetched to think of the mortgage giants on the brink of another rescue. Earlier this month, they reported robust profits and said they would send $10 billion to taxpayers. That brings their total remittances to the government to nearly $266 billion, a sum in excess of the $187.5 billion in aid they received to operate during the foreclosure crisis.

In return for forfeiting revenue, the companies are promised a government lifeline to make ends meet if they suffer a loss. Tapping that credit line would highlight eight years of congressional inaction that has left the companies in limbo. But allowing them to bulk back up brings its own political risk if it’s seen as a step toward re-establishing the mortgage giants as private companies that profit from taxpayer risk.

That’s the choice confronting Trump, who has stacked his administration with mortgage experts who call the status quo unacceptable. Chief among them is Mnuchin, who has the power to recapitalize Fannie and Freddie, but hasn’t signaled that he’ll use it.

“It’s something we’re going to very carefully consider before we come out with a plan,” Mnuchin told Fox Business News on Feb. 23. “We don’t want to do anything that would put the taxpayers at risk going forward, so this is something that’s going to take us a little bit more time.”

Industry might get a clue to the administration’s plans for the mortgage companies next month, when Trump releases his first budget plan. Like Mnuchin, Trump’s budget director, Mick Mulvaney wants action on Fannie and Freddie. Last year, as a member of Congress, Mulvaney introduced legislation to allow the companies to retain capital, a bill that won support from small-government groups.

Allowing the companies to rebuild capital, even without a promise to set them free from the government’s grip, could also trigger a legislative backlash from Congress that could make broad reform even more complicated.

House Financial Services Chairman Jeb Hensarling (R-Texas) is among the lawmakers who oppose recapitalization and want to minimize or eliminate the government’s role in the mortgage market.

“There’s a common view among most Republicans, in Congress anyway, that the worst-case scenario here is re-privatizing them,” said Jim Parrott, a senior fellow at the Urban Institute and former adviser to President Barack Obama. “What you do not want politically is to be subject to the narrative that you’ve taken the first step toward re-privatizing since 2008.”

A Treasury spokeswoman had no comment on the administration’s position on recapitalization. A Hensarling spokesman did not respond to a request for comment.

Some lawmakers may be reluctant to agree to a legislative fix because Fannie and Freddie have proved useful as a source of cash. In 2012, Congress funded a payroll tax cut by raising the guarantee fee, or g-fee, that the companies charge mortgage borrowers.

Tax reform, too, looms large for the companies. If Congress lowers the corporate tax rate, Fannie and Freddie would have to write down the value of deferred tax assets by as much as $30 billion, according to an analysis from Fitch Ratings. That could trigger a loss that forces the companies to seek taxpayer help.

Finally, any change to the current arrangement, known as Treasury’s net worth sweep of the companies, would land in a thicket of litigation and might give an edge to the hedge funds who bought Fannie and Freddie stock at bargain-basement prices.

Investors were dealt a legal setback last week when a federal appeals court said they couldn’t sue over the net worth sweep. Still, some of the biggest of those speculators, including John Paulson and Bruce Berkowitz, raised money for Trump’s campaign and are betting the White House will act in their favor.

“We are optimistic that the indispensability of Fannie Mae and Freddie Mac to affordable homeownership eventually overpowers the taboo imposed upon them by the previous Washington establishment,” Berkowitz told investors last month.

When Fannie and Freddie's losses do come, they’re are likely to be short-lived. In the long run, the companies should continue to report profits as home prices rise and default rates stay low. That’s another reason lawmakers aren’t eager to take on heavy lift of reform, said Christopher Whalen, senior managing director at Kroll Bond Rating Agency.

“The status quo is ugly and conflicted,” Whalen said. “There’s a huge downside for the politician who wants to wade into the crocodile-infested waters, but not much upside.”